Views From the Floor

A week of difficult questions: can there be life after corporate buybacks stop?; has the US stock market become dangerously concentrated?; and is there room for the US dollar to depreciate?


Do criticisms of buybacks – manipulate stock prices higher, crowd out investment, de-equitise public capital markets – have merit?
 

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Quote of the Week:

"This rally in equities is clearly not driven by fundamentals — it’s driven by the liquidity support from the Federal Reserve."

Torsten Slok, chief economist at Deutsche Bank Securities, on US stocks notching their biggest monthly rally since 1987 in April

 

If Atlas Shrugged: Life After Buybacks

Stock buybacks have been in the headlines recently – and not for the right reasons. From reports on how US airline stocks spent almost all of their free cash flow on buying back their stock (but are now asking for government bailouts)1 to politicians campaigning to ban them completely, buybacks are proving to be a contentious topic.

However, buybacks have collapsed since the onset of the coronacrisis, as firms looks to keep cash on the balance sheet (Figure 1). Indeed, share repurchases for S&P 500 companies by the end of 2020 is expected to be USD 371 billion – half of the USD730 billion spent in 2019, according to Goldman Sachs.2

We have previously examined the impact of share buybacks on price, highlighting the academic literature that identifies an announcement impact and the frictional impact of execution, based on analysis by Man Group’s own trading research group. In the period, we analysed share buybacks routinely accounted for over 5% of average traded value, at which level there is a significant impact on price (Figure 2). We are also mindful that where institutional and mutual fund investor flows have proven fickle over time, corporates buying their own stock has been the one true constant in flows.

So far, the financial sector accounts for some than 36% of the cancelled buybacks (Figure 3), followed by the energy, industrials and consumer discretionary sectors. In contrast, the information technology sector accounts for just 8% of the cancelled buybacks, despite its outsized presence within US indexes.

In an environment where corporate boards will likely been keener to see balance sheets shored-up, the reduction in buybacks may prove to be an influence on price returns.

Figure 1. US Gross Aggregate Buybacks (USD Million)

US Gross Aggregate Buybacks (USD Million)

Source: Compustat, Factset, UBS; as of 31 March 2020.

Figure 2. Frictional Effect of Buybacks on the Russell 1000 in 2018
  Monthly Buyback Executed (USD bn) Russell 1000 Monthly Value Traded (USD bn) Buybacks as % of Value Traded Estimated Impact (bp) Cumulative Impact (bp)
 Jan 18 41.5 1117.5 3.7% 22.0 22.0
 Feb 18 43.8 1201.8 3.6% 22.0 44.1
 Mar 18 49.6 1291.3 3.8% 22.0 66.0
 Apr 18 49.1 1111.7 4.4% 22.0 88.2
 May 18 50.7 1095.0 4.6% 24.8 113.0
 Jun 18 58.8 1264.4 4.6% 24.8 137.7
 Jul 18 67.4 1031.5 6.5% 29.6 167.3
 Aug 18 72.6 1047.3 6.9% 29.6 196.9
 Sep 18 73.0 1122.9 6.5% 27.3 224.2
 Oct 18 73.9 1454.8 5.1% 24.8 249.0
 Nov 18 74.5 1234.8 6.0% 27.3 276.2
 Dec 18 76.1 1285.4 5.9% 27.3 303.5
 Jan 19 75.5 1161.7 6.5% 29.6 333.1
 Feb 19 74.6 965.1 7.7% 31.7 364.8

Source: Goldman Sachs; as of February 2019.

Source: Goldman Sachs; as of 28 April 2020.

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Keep it in the FAAAMily

Periodically, the US stock market becomes dominated by its biggest stocks. In fact, the market cap of this ‘FAAAMily’ of five companies – Facebook, Apple, Amazon, Alphabet and Microsoft – is as big as bottom 350 companies. The market cap of these five stocks now make up 21.4% of the S&P 500 Index, the highest reading since the 1970s. Indeed, it is also higher than the 16.6% weighting afforded to the five biggest stocks during the dot com bubble in 1999, when the indices became dangerously lopsided towards the internet companies.

Still, it’s worth putting this in perspective: this concentration is at the lower end of the spectrum when compared to history: The S&P 100 Index currently makes up around 45% of the total value of the S&P 500 Index, 10 percentage points lower than the 55% all time high recorded in the late 1970s (Figure 4).

Source: Bloomberg; as of 4 May 2020.

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Could We See a Weaker Dollar?

The US dollar rarely weakens much during times of crisis. As the world’s reserve currency and a traditional safe haven asset, in times of crisis investors tend to sell non-dollar denominated assets and buy US dollars, providing a supportive bulwark for the greenback. However, we believe that conditions may be emerging which would allow the dollar to weaken.

Firstly, spreads on commercial paper and Libor basis swaps on the dollar are coming in, partly in response to the stimulus measures taken by the Federal Reserve (Figures 5-6). In addition, cross currency basis swaps suggest a glut of dollars, and in the aftermath of Fed rate cuts, there is no longer an interest rate differential to speak of versus other developed currencies. On their own, these conditions will not automatically see the dollar weaken: ultimately, we would need to see a recovery in trade, and for markets to begin to price some degree of economic normalisation. However, the Federal Reserve has done what it can to generate the necessary conditions and is, no doubt, thinking about the benefits of a weaker currency to aid recovery.

Source: Bloomberg, as of 28 April 2020.

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Source: Bloomberg; as of 4 May 2020.

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With contribution from: Ed Cole (Man GLG, Managing Director – Equities) and Dan Taylor (Man Numeric, CIO).

1. Source: Bloomberg; 16 March 2020.

2. Source: Financial Times; 7 April 2020.